The personal blog of Adam Nash

Why I love Timber as an Asset Class

I found this article on the Motley Fool this week called “Is Lumber the New Gold“, and it reminded me why Timber might be my favorite asset class of all.

I was first introduced to Timber as an asset class at Harvard Business School, in one of my classes on Venture Capital & Private Equity. Dave Swensen, who managed the Yale endowment for over 20 years, discussed the strategy that led Yale to incredible outperformance in the 1980s and 1990s. He took the endowment from $1.3 Billion to $14 Billion, using a strategy very different than his colleagues.

It would be a whole different post to sing the praises of Mr. Swensen, and his philosophy on investing has now become public knowledge since he released a book on the subject. In his discussion with the class, I remember his specific comments on assets that had extremely attractive risk/reward ratios. Private Equity is one, to be sure, but he also allocated over 20% of his funds to “real assets”, which included Timber.

Timber is fascinating as an asset class. Here is a summary, cribbed from a recent post on Seeking Alpha:

Less Volatility than Stocks. What? More reward with less risk? It shouldn’t be true, but it here at least empirically.

Timber is counter-cyclical with Stocks. Especially nice to have an asset that zigs when the stock market zags.

Money grows on Trees. Fundamentally, you have to like the fact that 6% growth every year comes from the fact that trees just grow bigger with natural sun & water. The value of trees is also non-linear, in that growers can just “not cut” in weak years for timber prices, and make even more in subsequent years.

Here’s a nice post from Seeking Alpha in July on why Timber should outperform in an inflationary market. It even features my personal favorite REIT stock in the sector, Plum Creek Lumber (PCL), which I’ve owned since 2002.

You have to love the web. I found this fantastic blog post from 2005 on Timber. Couldn’t have said it better myself.

Until recently, it was very hard to invest in timber without a portfolio allocation in the millions of dollars. However, now, there are several ways to add timber to your portfolio. My favorite are the REIT stocks, like PCL & RYN, which allow you to own companies who have a primary business in owning & maintaining timber land. Given the regulations around managing timber land, and the tax-advantages of the REIT structure, it’s hard to get better direct exposure.

It’s interesting, but as the trend continues towards development & environmental protection, these firms should have an even more compelling advantage as the supply of quality timber dwindles, and the regulatory environment grows more arduous. Even the sleepy paper companies are starting to look more valuable for the timber land that they own, rather than the product they produce.

It’s so interesting that money, in some cases, really can grow on trees.

Update (6/13/2007): A commenter forwarded me to a webpage that had a link to one of my favorite articles on timber as an ivnestment, from a 2001 issue of Smart Money magazine. Check it out here.

Actually, until the late 1990s, that was pretty much the only way to invest in Timber. There were limited partnerships that you could buy stakes in, usually at between $250K and $1M minimum.

The one thing I like about PCL/RYN is that with environmental regulation what it is, I think owning timber land is going to become like being a home builder – a patchwork of legislation nationwide. There may be significant scale advantages to being large enough to employe marketing and legal teams large enough to actually operate in the US.

That being said, I wouldn’t mind acquiring a hundred acres of a nice hardwood like cherry, and then harvesting a few acres a year indefinitely. I like the idea of infinite dividends that literally grow on their own.

How do you see young timber regen, such as aspen (main source of pulpwood for northern US paper producers), as a long-term timber investment for future timber value (15+ years ago from being mature). Would purchasing this land be a viable, riskier alternative to investing in a publicly traded timber REIT? I ask this because I live in Minnesota which has seen dramatic change in it land ownership over the last couple of years. Some of the paper companies have sold their land holdings to these large timber REITs. These REITs are now selling a significant amount if this land, mainly in smaller parcels, to private individuals. The timber on most of this land has been harvested in recent years and will not be ready to harvest for 15-30 years.

While there is a part of me that likes the concept of literally owning your own timber land, I have to admit that I haven’t done significant research in this area, and I don’t know what the overhead costs for maintaining the land & harvesting timber might be. From reading the PCL annual reports, it sounds like there is significant legal & environmental liability to owning woodlands these days – a real advantage to large REITs who can afford large legal teams and lobbyists. As a result, I would investigate very very carefully before ever trying to jump in and own timberland as an individual.

I like timber for all the reasons stated but don’t like owning an asset class composed of only two stocks (PCL and RYN). It would be nice if someone would start a timber mutual fund or ETF but there are not enough domestic timber companies to do so. With the inclusion of international companies there might be sufficient diversification. I have not branched out internationally in this sector, but have broadened my domestic investments to include Deltic (DEL), a REIT owner of timber in Arkansas and Louisana, and Timberwest Forest (TFTUF), a large timber company primarily operating on Vancouver Island. TFTUF is a “stapled unit”, whatever that is, but pays high dividends like an REIT. I know TFTUF is a Canadian company, but they are close enough to domestic to get the nod. Another REIT I don’t own is Potlatch (PCH), with holdings in Idaho, Arkansas and Minnesota, but they are more diversified and so less of a pure timber play.
Until there is a small-investor vehicle for the asset class I will stick with spreading my funds between PCL, RYN, DEL and TWTUF. Although PCL has most of the market cap, it has underperformed the others over the past couple years so investors might want to consider equal, rather that market-cap weighting.

I appreciate the comments and the thought behind them. Theoretically, you are correct, although given PCL’s excellent management and scale, it’s likely that they fairly represent the timber opportunity given the large acreage and geographic area covered.

A balanced portfolio of the stocks might be a better match for a theoretical timber index – I’m not sure. For the most part, not a lot of companies/REITs are pure plays in timber.

The fact that PCL has underperformed these other companies in the past two years doesn’t concern me, since it’s unclear to me that the performance of these other companies is related to their timber management. PCL is clearly run for the long term, so they will forfeit sales and profits in the short term to best yield long term value from their real estate and timber holdings.

Adam,
it is nice to see an ode to timber REITs. All four reasons from “Seeking Alpha” are valid in general, but there is a bit more to that:
1. Returns are difficult to mesure if you do not have a “pure timber” stock. Right? So far, the only educated guess may come from NCREIF index return, but there are issues with that too.
2. Volatility, higher or lower, can be measured and applied for a liquid asset, and timberland is hardly that. Thus, there is probably a reason for that lower volatility.
3. Counter-cyclical nature of timber is in part due to biological growth of timber (point 4) and in part – low liquidity. At the same time if you take the current 3 public timber REITs and compare them to S&P 500 for the past year or so – the difference is slim. Then again – none of the REITs are in “pure timber”, most draw only 20-45% of gross revenues from timberlands. The only company with 80%+ revenues from timberlands is Pope Resources, but they are fairly small.

I agree, I love Timber Stock too. It has sustainable growth for the near future which a lot of commidities lack these days. As opposed to oil, Timber Stock is an investment for the future, ecologically and financially. I found an article recently that helped really open my eyes to the importance of Timber Stock as a strong investment.

I also love timber. In fact, I created a marketing program for financial advisors around a new timber REIT introduced last year. . If you would like to review it I would be more than happy to send you some information. Unlike some of the other REITS which dabble in timber and focus on paper and other byproducts, this is a 100% pure play on timber.

Nice article Adam. I wasn’t really sold on timber assets over the last few years because of the real estate bubble, but what would be your thoughts today? I’m doing some bottom fishing and the 4.7% dividend on PCL looks pretty good.

Would you be fairly gung ho about picking up a few shares even though the home builders are scaling back new home production?

I think following the ups and downs of the housing market is a mistake when it comes to timber. The beauty of the asset class as a long term asset is that it continues to grow and gain value with minimal carrying costs, even when the short term price of the commodity is low.

Therefore, firms that manage timber assets, if managed correctly, cut back their sales in low price environments, and “save” their timber for future years.

I try to pick up PCL whenever I need to add to my timber assets to maintain a fixed % of my portfolio.

This is a very interesting sector and a relative new space in that natural resources asset class. I also closely follow the Yale Endowment Model for complete diversification.

However your comment :

” Timber is counter-cyclical with Stocks. Especially nice to have an asset that zigs when the stock market zags. ”

Based on a few of the annualized performance charts, technically speaking that I pulled for PCL, RYN and CUT did not seem to present much negative correlation to the SP? Do you have other data that shows this empiracally or graphically?

These have been done for timber as an asset class. To be honest, PCL, RYN, and CUT have been around too little time for this comparison to be meaningful. Also, as tradable entities on the stock exchange, by definition their correlation to stocks will be much higher than the asset class itself.

See my other post on why the correlation for a variety of asset classes has been going up over the past decade, due to the increasing ability for everyone to trade and own these assets.